OPTIONS TRADING – TERMINOLOGIES
In our earlier article, we discuss the basics of option, here we focus on the terminology involved in the options trading.
Just we recall the definition of options once in a simple way.
The seller gives a buyer the right, but not the obligation to buy or sell a specific number of shares at a predetermined price within a specified time limit.
In a simple way, it looks like an insurance business. Buyers are policyholders and sellers are insurance sellers.
· If you buy a car insurance policy, if there is no accident, insurance companies get benefited.
· If any damage occurs, you will claim your insurance amount. The same way options trading works. Let us have a look at it.
TYPES OF OPTIONS TRADING:
Basically, there are two types. They are,
· Call option
· Put option
The call or Put option gives the buyer the right, but not the obligation to buy or sell the underlying asset by a certain date (expiry date) at a specified price (exercise price or strike price).
Beginners will be having some doubt what is the expiry date and the strike price, its same as any product have an expiry date. Let us have a quick recap.
Exchange-traded options contracts expire according to the exchange calendar.
In India, stock option contracts are expired on the last Thursday of every month.
Index trades are expired at every week.
If the last Thursday is a trading holiday, the contract expires at the previous trading day.
On the expiry date, all the contracts are to settle with complete compulsion.
The price at which a put or call option can be exercised.
Still, it’s a confusing term, simply strike price is your directional target of the stock price movement.
The selection of strike price depends upon the moneyness of the option.
OPTIONS TRADING – BUYING VS SELLING:
Most people have a lot of confusion regarding option buying and selling. The buying of options required only a premium but the selling of options required a huge margin.
Let us look at the image below, you get a clear idea about options buying and selling
It is all about what’s your expectation about the market, if you expect the stock price will increase in the coming months buy a call option.
In the same way, you buy a put option if the market conditions reverse. The selling of options is totally reverse to the market condition.
MONEYNESS IN THE OPTIONS TRADING:
Moneyness is a term describing the relationship between the strike price and spot price of the underlying asset. Let us have a discussion on the terms involved in the moneyness of options.
Oh my god, how many terms we have to remember for options trading, Is it our mind voice?
It is not as complicated as we think, let us make simple.
Imagine a stock and the current market price of the stock. Only one condition that stock should be qualified in the future and option segment.
Maybe it looks like round table confusion.
· How it is related to option trading?
· Why we have this classification?
Simply understand the concept first. For example ITC trade at around 190 rupees in a current market. If you expect the price of the stock will increase above 200 this month.
What will we do? We can/will buy the stock in the cash market or buy the call option.
Here you need to understand the term strike price at what strike price I will take the call option. Its depends on the following criteria
· Market volatility
· Time decay
· Historical price movement of the stock
· Earnings results of the company
If we choose 200 as a strike price of the call. It means the price of the stock will move above 200 in this expiry then only we get maximum profit.
If the market closes below 200, we will end up with the loss of the premium paid.
For example, a premium of the ITC 200 call option is 3rs. We get excited, only three rupees as a premium.
We have already mentioned in our previous article, future and option are traded in the multiples of the lot.
Any guess what is the lot size of ITC? Currently, it is at Rs. 3200 so our premium is Rs. 9600.
Once we play with options, we can understand these terminologies very well. It all depends on the stock price movement. Predict the stock price and pick the correct strike price to trade.
· Options trading is introduced for hedging in derivatives markets to minimize the risk of a long position in cash or future market.
· But people play like gamblers in the options market.
· Remember one thing option is a suicide game. All the financial products have a specified purpose
· Understand the usage of option and use properly.
· If you understand clearly then take a trade otherwise don’t go for it.
· Learn the concepts first and earn money in the market.